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Explaining the Capital Gains Tax for the Sale of a Business

written by: Sandi Johnson•edited by: Michele McDonough•updated: 2/3/2011

Capital gains are profits from the sale of assets. The IRS requires reporting of all capital gains and losses. Capital gains for the sale of a business can range as low as 15% or as much as 28%, depending on numerous factors.

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    What Are Capital Gains Taxes?

    The subject of capital gains tax (sale of business) is simple. Capital assets, as they relate to a business, include real estate, equipment, inventory, and intellectual property, just to name a few. According to the Internal Revenue Service, capital gains are the difference between the purchase price or basis value of a capital asset and its sale price. A capital gain indicates a profit, taxable as income. A capital loss indicates a deficit, eligible for deduction in some instances. Most capital gains are taxed at 15%, although percentages can range as high as 28% for Section 1202 small business stock.

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    Prepare to be Taxed

    capital gains tax sale of business When buying a business, information for determining the value of the business, developing business plans, and other advice is readily available. However, when you decide to retire or otherwise sell your business, few organizations lay out everything you should know or do in an easy to understand format. Business brokers can appraise the value of your business. The SBA and banking institutions, alone or in conjunction with a business broker, provide assistance with planning, qualifying buyers and facilitating the sale.

    Unfortunately, most sale facilitators have little or nothing to offer in terms of tax advice concerning capital gains tax sale of business. According to Tom Jeffreys, former owner of Tom Jeffreys Sign and Banner in Huntsville, AL, these entities generally assume you have an accountant to manage such matters. In his experience, the SBA, business brokers, and banks focused more on educating the buyer than the seller.

    Tom sold his 20 year old sign business in 2010 and advises you may not find the same free-flowing financial advice when selling your business as you experience buying or establishing your business. According to Tom, most facilitators leave you to determine tax issues on your own or with an accountant. As such, consult a tax professional, accountant, or tax attorney before the sale to make sure you understand the tax implications of selling your business.

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    Capital Gains at a Glance

    Selling a business at a profit means there is money left over, above the value of business assets. While it is easy to think that capital gains are simply the difference between the value of the business and its final sale price, the IRS does not see it quite so simply. Much of the effects of capital gains tax on sale of a business depend on the type of business entity and ownership of individual assets.

    The IRS does not see the business as a whole, but rather as individual capital assets such as equipment, real estate, and inventory. The sale of a business, as far as the IRS is concerned, involves the transfer of individual capital assets. It is possible to realize a capital gain on equipment, for example, while realizing a loss on inventory. As such, selling a business at a profit to the owner does not necessarily equate to selling a business at a profit to the IRS.

    The IRS classifies business assets as short term or long term. Short-term assets are held for one year or less. These include finished product inventory, raw materials, and similar assets. Long-term assets are held for more than one year, such as equipment, real estate, or patents. A quick perusal of IRS Schedule D, Capital Gains and Losses provides insight into how the IRS computes gains and losses for the sale of a business using short and long-term asset calculations.

    Depending on the nature of the assets involved and the business entity, profits from the sale of a business qualify as either personal income or capital gains. Capital gains tax rates are lower than personal income tax rates. In that regard, owners in the market to sell should want profits to fall in the category of capital gains, rather than personal income. However, each business and individual is different, therefore the effects of capital gains tax on sale of a business varies greatly and warrants consult with a tax professional.

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    References and Resources

    IRS Topic 409, Capital Gains

    Dun & Bradstreet, Tax Issues to Consider Before Selling a Business

    The Huntsville Times, SBA Loans

    Tom Jeffreys, (February, 2011). Telephone interview.

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